One nation, divisible. As government's role recedes, capitalism and democracy clash

By Lester C. Thurow, in The Boston Globe,9 September, 1997

With a booming stock market and falling real wages for the bottom 60 percent
of the work force despite a rising real per capita GDP, inequalities in
earnings and wealth have been rising at record rates in the United States in
the last decade. Viewed narrowly, this creates few economic reasons to be
concerned. The economy will gradually shift to produce more of those goods
wanted by the rich and fewer of those wanted by the middle class. There will
be no shortfall in aggregate demand. Technically, capitalism can adjust to any
degree of inequality. American capitalism did, after all, coexist with slavery
for a long time.

The problems are those of conflicting ideologies and social conflict. Democracy
and capitalism have very different core values. Democracy believes in
radical equality -- one vote per person no matter how smart or dumb, how
hard-working or lazy, how well-informed or ignorant. Capitalism believes in
radical inequality. Differences in economic returns create the incentive
structure necessary to keep everyone working hard and investing in the fu-
ture.

In market economies wealth leads to wealth and poverty to poverty since investments in human or physical assets, and hence future income, depend on
current income. There are no equalizing feedback mechanisms in capitalism.
The economically fit are supposed to drive the economically unfit out of existence. The phrase ''survival of the fittest,'' in fact, was coined by a 19th-century economist, Herbert Spencer, and borrowed by Charles Darwin to
explain evolution. In 19th-century economics starvation had a positive role to
play in the economic system.

Historically the social welfare state and social investments in education have
been used to make capitalism and democracy compatible. The state would
take actions (progressive taxes, for example) to equalize market outcomes,
and would help provide for necessities (with, say, a special tax benefit for
home mortgages). The state would provide support when individuals are no
longer wanted by the market (pensions, health care, unemployment insurance), and would help individuals get marketable skills (public education) so
they could earn a good living.

Just as important as its objective results, this system put the state
visibly on
the side of equality. Low- and middle-income individuals could see that they
had a friend in court, so to speak. To get ahead, they did not have to overthrow the system.

The elderly are putting this system at risk. Ever larger government expenditures on ever more numerous elderly voters have to be financed by reducing
social welfare benefits for other groups, by cutting social investments in the
future (education, infrastructure, and research), or by raising regressive payroll taxes.

The last becomes impossible with globalization. Higher payroll taxes raise the
effective wages that firms have to pay and end up simply driving industries
and employment abroad -- as is now dramatically visible in Europe. Those
left behind have to pay higher and higher taxes to support the elderly.
Lower social investments in education, skills, infrastructure, and knowledge
generation (research) make American companies and workers less competitive in world markets. With lower earnings, both are less able and less willing
to pay the taxes necessary to finance investments in their own future.
Lower social welfare benefits will eventually create a lumpen proletariat (in
19th-century language), or underclass (in 20th-century terms), unattached to
either the economic or social system. Some will leave welfare for work and
others will just leave welfare. Their skills and habits are such that no
private
firm is going to want them. As their numbers grow, something eventually has
to crack.

The system that has held democracy and capitalism together for the last century has started to unravel. As earnings distributions widen due to globaliza-
tion and a skill-intensive technological shift, and as government seems unable
or unwilling to do anything about it, that majority of workers who face lower
real earnings has to become disaffected sooner or later with democracy. In
Europe, where the equivalent of falling wages is ever higher unemployment,
authoritarian non-demo-cratic parties on the right are already getting a chunk
of the vote in France and Austria.

Finding a new way to link democracy and capitalism symbiotically is apt to
be the economic and political problem of the next century. The answer has to
be found in a reinvigoration of the social investment state. But this is
exactly
what we are not doing. In our federal budget, investment activities have been
cut in half in the last 25 years. Looking forward, President Clinton and the
Republican-dominated Congress plan to cut them even more sharply as they
move toward a balanced budget in the early 21st century.

Lester C. Thurow is professor of management and economics at the MIT
Sloan School of Management.